PAYROLL TAX INCREASE FOR LARGE WA EMPLOYERS Economic Analysis

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1 PAYROLL TAX INCREASE FOR LARGE WA EMPLOYERS Economic Analysis SUMMARY This study investigates the impact of increasing the payroll tax burden to 6 per cent for payrolls that exceed $100 million, and to 6.5 per cent for payrolls that exceed $1.5 billion, on the economy and employment in WA. This increase is forecast by the WA State Government to raise $435 million over three years $135 million in the first year. The study concludes that the WA State Government s payroll tax increase for large WA employers will result in a loss of between 1,334 and 5,297 jobs, and reduce economic output in the private sector by at least $510 million. A reduction in economic activity of $510 million would result in forecast growth in Gross State Product for WA reducing from 3 per cent (CCI forecast) to 2.8 per cent in The cost of the payroll tax increase will impact all businesses large corporations and small and medium sized enterprises (SMEs). CCI modelling has identified that 32 per cent of job losses will occur directly in large businesses. The remainder will be lost in SMEs. This means that 426 direct job losses will occur in the largest employers that are required to pay payroll tax, and a further 908 will be lost across the wider economy. Many SME s will reduce 1 employment to pay for the flow on effects of the tax increase. The industries that will lose the most jobs are mining (269), construction (234), administrative and support services (120), and manufacturing (113). By the third year of the Government s payroll tax increase, the jobs lost in WA will increase from 1,334 to 1,489. Jobs in SMEs can however be protected by increasing the payroll tax threshold. A $100,000 increase of the payroll tax threshold from $850,000 to $950,000 will create 278 direct and 602 indirect jobs, which will partially offset the 1,334 jobs lost by the payroll tax rate increase in the first year. Increasing the threshold by $100,000 would reduce budget revenue by $47 million, reducing the total additional payroll tax raised from $135 million in the first year to $88 million. Increasing the payroll tax threshold by $100,000 would offset 65 per cent of jobs forecast to be lost whilst reducing the increased payroll tax receipts by just 35 per cent. Recommendation: Do not increase payroll tax rate, or at the very least increase the payroll tax threshold by $100,000 to partially offset job losses in small and medium sized businesses in WA.

2 BACKGROUND In the 2017 State budget the WA Government introduced a new payroll tax scale for large employers. The increased tax rate will apply from 1 July 2018 for a finite period of five years. Payrolls that exceeded $100 million will pay an increased marginal rate of 6 per cent up from 5.5 per cent. Payrolls that exceeded $1.5 billion will pay an increased marginal rate of 6.5 per cent, up from 5.5 per cent. The State Government has identified that the top 8 per cent of payroll tax contributors will be impacted directly by the tax increase. CCI estimates that these largest businesses employ 400,000 West Australians representing roughly one third of all employees in the state. It is estimated by the WA Government that $435 million will be raised over three years by the increased tax rate. In the first year ( ) $135 million will be raised. METHODOLOGY Payroll tax is a state tax levied on income paid by an employer to their employees when total payroll exceeds a tax-free threshold. In order to assess the potential economic effect of a change to the payroll tax rate for larger employers, the following methodology was followed: Examine literature and interview large CCI members to determine marginal propensities of businesses when faced with an increased payroll tax rate; Model the potential economic impact of a change in the rate driven by behavioural change by industry using ABS National Account input/output table derived multipliers; Identify costs and benefits associated with a change in the rate; Draw conclusions from the analysis. The economic model that was used for this analysis was built by independent consulting group Pracsys in THE CHOICE FOR BUSINESS Faced with an increase in payroll tax payable, businesses have a choice as to how to respond. Businesses have the option to pass on the increased tax burden in three ways: to shareholders (reduced profit), to employees (reduced employment), to contractors (reduced contracts), or through lower investment and research and development (R&D). Employment is defined as full time equivalent (FTE) employment at median wage price by industry. It has been conservatively assumed that the behavioural propensity for businesses is as illustrated in the chart opposite: Literature supports the marginal propensity assumptions. Kugler and Kugler (2001) of Stanford University studied the effects of payroll tax changes and the associated propensities to make the decisions highlighted above. 1 It was concluded that a 10 per cent increase in payroll taxes reduces employment between 4.2 per cent and 4.9 per cent suggesting a marginal propensity to pass on higher payroll tax costs as reduced employment of between 0.42 and Therefore, this study s assumption on pass through of costs to employment at is very conservative. Explicitly stated, it is assumed that more than half of the cost of the increase in payroll tax will be passed on to shareholders through lower profits. Large members of CCI that are liable for the payroll tax increase have indicated that they are obliged to protect shareholder returns and therefore they will have no choice but to pass a significant part of the increase onto labour and suppliers. This supports the marginal propensity assumptions made and confirms they are conservative. MARGINAL PROPENSITY THIS STUDY KUGLER & KUGLER (2001) Decrease profits 0.55 Decrease employment Decrease contracting Kugler and Kugler (2001), Effects of Payroll Taxes on Employment and Wages Working Paper 134, Stanford University. 2

3 PAYROLL TAX BY INDUSTRY Payroll tax is not paid evenly by industry. The WA Department of Treasury has provided the following distribution across industries for [Figure 1] The three highest contributors to payroll tax payments are mining (23 per cent), construction (14 per cent), and professional, scientific and technical services (9 per cent). These distributions have been used for this study, and their distribution among the highest payroll tax bracket is assumed to be the same as the distribution across all businesses who pay payroll tax. However, we recognise that the State s largest businesses liable for the new payroll tax levy may be concentrated in a few select industries. In the absence of more detailed payroll tax receipt data from WA Treasury, it is assumed that the distribution is constant across tax brackets. Given that the industries likely to be underrepresented by this assumption, such as mining, have higher employment multipliers than industries that are possibly overrepresented, this assumption is conservative. RESULTS The study concludes that the proposed increase to payroll tax for large employers, as announced by the WA Government, will result in a loss of 1,334 jobs and will reduce economic output in industry by $510 million in the first year. [Figure 2] The cost of the Government s payroll tax increase will impact all businesses, including large corporations and SMEs. CCI modelling has identified that 32 per cent of job losses will occur directly in large businesses the remainder will be lost across the wider economy. 426 direct job losses will occur in the large employers that are required to pay payroll tax, and a further 908 will be lost through the decline in aggregate demand for goods and services. Critically, this outlines that job losses are not contained to the large employers liable to pay the tax. The industries that will lose the most jobs are mining (269), construction (234), administrative and support services (120), and manufacturing (113). [Figure 3] 3

4 JOB LOSSES WILL INCREASE OVER TIME The total payroll tax raised from the proposed rate will increase over time as WA s economic activity strengthens. In the first year ( ) the additional tax raised is $135 million which has formed the basis of the analysis. By the third year ( ) the tax increase will raise an additional $155 million. Job losses will increase from 1,334 to 1,489 in the third year. PROTECTING SMEs JOBS Job losses will not be limited to larger employers who are directly liable for the tax. The cost of the tax will be passed through the economy to all businesses. [Figure 5] Jobs in SMEs can be protected by increasing the payroll tax threshold. A $100,000 increase to the payroll tax threshold from $850,000 to $950,000 will create 278 direct and 602 indirect jobs, partially offsetting the 1,334 jobs lost by the payroll tax rate increase. The result in direct and indirect job losses is expected to be reduced from 1,334 to 454 in the first year of the tax. 65 per cent of jobs can be protected by increasing the payroll tax threshold by $100,000 which reduces the additional tax raised by 35 per cent ($47 million). [Figure 6] Recommendation: Increase the payroll tax threshold by $100,000 to partially offset job losses in small and medium sized businesses in WA. 4

5 IMPACT ON STATE DEBT The increase in payroll tax will only have a small impact on total net debt. By 2021 the payroll tax increase will decrease net debt by less than 1 per cent whilst removing more than 1,334 West Australians from employment. $435 million of net debt will be reduced whilst reducing economic activity in WA by more than $1.5 billion. [Figure 7] 65 per cent of debt reduction from the payroll tax increase can be achieved, whilst offsetting 65 per cent of WA jobs lost, by increasing the payroll tax threshold by $100,000, as proposed by CCI. SCENARIO ANALYSIS FULL PASS THROUGH TO EMPLOYMENT As many as 5,297 WA jobs may be lost if business recoups the increased payroll tax rate entirely by reducing employment in the first year. The economic model allows for running scenarios to determine a range 5 of possible outcomes. One scenario is that businesses decide to pass the entirety of the additional payroll tax cost through to employment. In this scenario direct employment loss increases to 1,891 and total employment loss across the wider economy (including the direct lost employment) is 5,297.